Thursday, March 20, 2008

"The bubble of irrational exuberance in infrastructure and public-private partnerships has been pricked. "

Pricey debt drives infrastructure down road to nowhere

March 20, 2008

Michael WestThe Age (Australia)Copyright 2008

INFRASTRUCTURE projects are falling victim to turmoil on world markets as the rising cost of debt and shattered confidence discount the price governments can get for privatising their assets.

The bubble of irrational exuberance in infrastructure and public-private partnerships has been pricked. Big write-downs on Sydney's Lane Cove Tunnel toll-road project are as much about flawed traffic forecasts as falling asset values, but the pool of funds available for PPPs, both debt and equity, has shrunk. And the cost of financing the likes of hospitals, roads, schools, desalination plants, airports and jails is rising. This suggests assorted state treasuries will be taking a haircut on their estimates of how much money they will make from selling assets.

An aside: revelations that the NSW Government will proceed with its long-awaited metro rail line through the north-west of Sydney will trigger potentially hundreds of millions in penalty fees to infrastructure company Transurban, operator of Sydney's M2 Motorway and Melbourne's CityLink. The contracts are still secret, despite freedom of information requests, but are believed to contain indemnity clauses for losses suffered by the private operator due to new and competing transport facilities. Once again, the NSW Government shoots itself in the foot.

Macquarie Equities' transport analyst, Ian Myles, said the Government and Transurban (which bought the road from Macquarie Infrastructure) would renegotiate the project.

The M2 Hills Motorway prospectus says: "The parties must negotiate in good faith to ensure the lower of the equity return they would have received if the event had not occurred and the BASE case equity return (11.65% real after tax).

"Alternative public transport infrastructure. The minister must consult with the company in good faith in respect of any proposed development or granting of a concession in respect of any transport infrastructure servicing the specified region of north-west Sydney which could reasonably be expected to have a material effect on the project. The minister must have regard to the effect on the M2 and the fact it is the principal passenger and freight arterial route serving the north-west … of Sydney."

As the M2 has 25 years yet to run on the concession deed when the metro line is opened, the penalties may be substantial.

That's the bad news for taxpayers.The bad news for the corporate sector has already been felt for two months as listed sharemarket infrastructure players have been flayed by investors. Deal originators such as Macquarie and Babcock have watched the price of their shares halve while dedicated infrastructure companies such as Transurban, ConnectEast, Rivercity Motorway and Macquarie Infrastructure Group have come under pressure.

Most of these are highly leveraged stapled securities, an unpopular cocktail in the present climate.

But the news is not all bad. The failure of the Lane Cove Tunnel may prove cynics' contention that traffic forecasts are in some cases built to fit in with the business model, not the other way round.

When Cheung Kong Infrastructure conceded it would write down its remaining $113 million stake in the tunnel to zero, and construction group Leighton followed by foreshadowing a 70% write-down of its $117.5 million share, the view that traffic forecasts had been too bullish firmed.

Sydney's Cross City Tunnel, which opened in 2005, was an even greater debacle, with a target of 90,000 cars. The reality? Not even 40,000. The Cross City Tunnel did not even make it to the sharemarket.

Finally, Transurban is beginning to eke out a profit as its projects pass through ramp-up, mature and spit out cash from tolls. Though risk remains - particularly whether people will drive cars in 10 years if the oil price keeps rising - Transurban quelled leverage concerns with a $1 billion refinancing.

Market woes will mean that all players will have to scramble for institutional equity, which is not interested in sinking big licks of capital into these projects in this environment.

Elsewhere on the capital front, the banks (the locals and largely Europeans, some of whom are caught up in the credit market implosion), who have committed to underwrite the debt for these projects, will start baulking. Thankfully, it is US rather than European banks that are in the eye of the storm.

Still, should things get rough, their commitment letters no doubt will have several outs. Blow-ups and even delays arising from such incidents will not lend comfort to a reticent equity market, nor to government vendors.

One stock that appears to be in a spot of bother now is Rivercity Motorway. Rivercity units are changing hands for barely half their $1 float price.

A recent note from UBS mentioned an adjustment to the analysts' assumptions about the dividend reinvestment plan (DRP) over the remaining construction period.

Rivercity, which is building a motorway in Queensland, could have to pass the hat around for more equity.

UBS had assumed $150 million would be raised through the DRP. Since the security price halved, the group could be left with an estimated shortfall of $50 million. UBS said that it expected "ongoing weakness over the remaining construction period of two years. Management may therefore need to draw down additional debt or potentially cut distributions to fund this shortfall."

A keenly watched barometer of the toll-road sector will be ConnectEast. Its EastLink freeway is expected to open ahead of schedule. Management has been trying to dampen market expectations because lacklustre traffic would ensure the stock price got shellacked.

For the consortium that is privatising Brisbane Airport, an early stage project, sourcing finance at the right price could be tricky.

Finally, the call from Macquarie analyst Ian Myles on a possible outcome for Transurban, when it comes to its negotiations on the north-west rail line in Sydney, is that the M2 may be widened.

"From our perspective the M2 has shown another element of its option value," he said. "The Government, in its desire to address the public transport issues in the north-west, will need to engage with Transurban (M2 owner). The M2 has a series of desires itself, namely widening the road to three lanes, possibly buying back the deferred concession notes at a sound discount (to help fund the toll road), shift to full electronic tolling and possibly a shift to per-kilometre usage."

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